The Relationship between Price Elasticity and Sales Revenue | Economics

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The Relationship between Price Elasticity and Sales Revenue!

The proper estimation of price elasticity is of great significance for business decision making. A firm’s revenue changes as a result of the change in price.

Total revenue (TR) earned from sales by a firm is ob­tained by multiplying average unit price with the total quan­tity sold, i.e., TR = P x Q.

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In Figure 8, the total revenue obtained from OQ quantity sold at OP price is OPCQ. Here, three things are clear:

(1) If the demand price is elastic, with an increase in price, there is a large fall in sales so that the total rev­enue decreases. On the other hand, if the price falls, the sales increase so much that the total revenue rises.

(2) If the elasticity of demand is equal to unity, there is no change in total revenue earned from sales even with the change in price. For example, with the fall in price by 5%, the sales will increase by 5% whereby the total revenue will remain unchanged.

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(3) If the demand price is inelastic, the sales will fall with the increase in price but the totalrevenue will rise. On the other hand, with the fall in price, the sales will increase but the total revenue will fall.

In general, unity elasticity is not found in practice. When price changes in a certain ratio, the sales normally change in a high or low ratio.

Thus, if the management wants to increase sales, it has to reduce the price. But if the reduction in price is compensated by the additional sales, the total revenue will increase or remain the same. Similarly, the management can raise the price of product for increasing revenue.

But if the fall in revenue as a result of sales reduction is not compensated by the increased price, the total revenue will fall. Hence, the effect of a change in price on the sales determines the effect of the change in price on total revenue. Moreover, the firm often remains in a fix as to whether the sales should increase or decrease. In such a situation, the concept of the marginal revenue is decisive.